May 27, 2025

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Inheriting an investment account can be a financial windfall, but it also comes with tax implications that vary depending on the type of account. Understanding these tax consequences can help beneficiaries make informed decisions and avoid unnecessary tax burdens. Below, we explore the tax treatment of different inherited investment accounts.

Taxable Investment Accounts (Brokerage Accounts)

When inheriting a taxable brokerage account, the key tax benefit is the step-up in basis. This means that the cost basis of the assets is adjusted to their fair market value on the date of the original owner’s death. When the beneficiary sells the assets, capital gains taxes are only due on any appreciation that occurs after the inheritance date.

For example, if the original owner purchased stock for $10,000 and it was worth $50,000 at the time of their passing, the beneficiary’s new cost basis would be $50,000. If the stock is later sold for $55,000, capital gains taxes would apply only to the $5,000 gain.

Traditional IRAs and 401(k) Accounts

Inheriting a tax-deferred retirement account such as a Traditional IRA or 401(k) can result in significant tax consequences. The beneficiary generally has several distribution options, depending on their relationship to the deceased and the account holder’s age at death.

1. Spouse Beneficiary – A spouse can roll the inherited IRA into their own IRA and defer required minimum distributions (RMDs) until they reach age 73. This allows for continued tax-deferred growth.
2. Non-Spouse Beneficiary – Under the SECURE Act, most non-spouse beneficiaries must withdraw the entire balance within 10 years of the original owner’s death, potentially resulting in a large tax bill. However, there are no annual RMDs, allowing for flexible withdrawals within the 10-year period.
3. Eligible Designated Beneficiaries (such as minor children, disabled individuals, and beneficiaries within 10 years of the decedent’s age) may be allowed to stretch distributions over their lifetime.

Withdrawals from inherited Traditional IRAs and 401(k)s are taxed as ordinary income, which can push beneficiaries into a higher tax bracket if large sums are withdrawn in a single year.

Roth IRAs and Roth 401(k)s

Roth accounts have different tax implications due to their tax-free withdrawal structure:

• Spouse Beneficiary – A spouse can roll the inherited Roth IRA into their own Roth IRA, allowing tax-free growth and avoiding RMDs.
• Non-Spouse Beneficiary – Must withdraw all funds within 10 years, but withdrawals remain tax-free if the account has been open for at least five years.

Because Roth accounts are funded with after-tax dollars, beneficiaries do not owe income taxes on withdrawals, making them one of the most tax-efficient assets to inherit.

Annuities

Annuities have more complex tax rules depending on whether they were held in a qualified (tax-deferred) or non-qualified account:

• Qualified Annuities (held in an IRA or 401(k)) – Subject to the same tax rules as inherited retirement accounts, with withdrawals taxed as ordinary income.
• Non-Qualified Annuities – Only the portion representing earnings is subject to income tax, while the original investment (cost basis) is received tax-free. Beneficiaries may have the option to take distributions over a period to manage tax liability.

Life Insurance Proceeds

While not an investment account, life insurance is often part of an inheritance. Fortunately, life insurance proceeds are generally tax-free to the beneficiary, unless they are part of a taxable estate exceeding federal or state estate tax exemptions.

Estate and Inheritance Taxes

While most inherited accounts do not trigger federal estate taxes for beneficiaries, estates exceeding the federal estate tax exemption ($13.61 million in 2024) may be subject to taxation. Some states also impose inheritance or estate taxes, so beneficiaries should check their state’s laws.

Key Takeaways for Beneficiaries

• Taxable brokerage accounts benefit from a step-up in basis, reducing capital gains taxes.
• Traditional IRAs and 401(k)s require withdrawals that are taxed as ordinary income, often within 10 years.
• Roth IRAs offer tax-free withdrawals but must be distributed within 10 years for non-spouse beneficiaries.
• Annuities have complex tax rules, depending on their type.
• Life insurance proceeds are generally tax-free.
• Estate and inheritance taxes may apply in certain cases.

Understanding these tax rules can help beneficiaries make strategic financial decisions. Consulting with a financial advisor or tax professional is recommended to optimize inheritance planning and minimize tax burdens.

Important Disclosures:

Securities offered through IFP Securities, LLC, dba Independent Financial Partners (IFP), member FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a Registered Investment Advisor. IFP and Finspire, LLC are not affiliated.

Neither IFP Advisors LLC, IFP Securities LLC, dba Independent Financial Partners (IFP), nor their affiliates offer tax or legal advice. Any potential tax advantages or benefits will depend on your circumstances. Consult your tax professional and/or legal expert about your individual tax situation and visit IRS.gov to learn more. Securities offered through IFP Securities, LLC, member FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, a registered investment adviser. IFP and Finspire, LLC are not affiliated. This communication is provided for informational purposes and should not be construed as tax advice, Consult your tax professional for more information.